Deluxe Corporation
Q1 2013 Earnings Call Transcript

Published: 25 Apr 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q1 2013 Deluxe Corporation Earnings Conference Call. My name is Allison, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Mr. Jeff Johnson, Treasurer and Vice President of Investor Relations. Please proceed, sir.

[Jeff Johnson:]

Thank you, Allison. Welcome to Deluxe Corporation's 2013 First Quarter Earnings Call. I am Jeff Johnson, Deluxe's Vice President of Investor Relations and Treasurer. Joining me on the call today are Lee Schram, Deluxe's Chief Executive Officer; and Terry Peterson, Deluxe's Chief Financial Officer. Lee, Terry and I will take questions from analysts after the prepared comments. At that time, the operator will instruct you how to ask a question. In accordance with Regulation FD, this call is open to all interested parties. A replay of the call will be available via telephone and Deluxe's website. I will provide instructions for accessing the replay at the conclusion of our teleconference. Before I begin, let me make this brief cautionary statement. Comments made today regarding financial estimates and projections and any other statements addressing management's intentions and expectations regarding the company's future performance are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. As such, these comments are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Additional information about various factors that could cause actual results to differ from those projected are contained in the news release that we issued this morning and in the company's Form 10-K for the year ended December 31, 2012. In addition, the financial and statistical information that will be reviewed during this call is addressed in greater detail in today's press release, which is posted on our Investor Relations website at deluxe.com/investor, and was furnished to the SEC on a Form 8-K filed this morning. In particular, any non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release. Now, I'll turn the call over to Lee.

[Lee J. Schram:]

Thank you, Jeff, and good morning, everyone. Deluxe delivered an outstanding quarter to start the year. We reported revenue and adjusted earnings per share above the high end of our outlook. Revenue grew almost 3% over the prior year quarter, even though there were 2 less business days compared to last year. Small Business Services' revenue grew 8%. Checks and forms both performed better than our expectations, and marketing solutions and other services revenues grew 22% over the prior year. Adjusted diluted earnings per share grew 3% over a very strong prior year. We generated solid operating cash flow, and we were not drawn on our credit facility during the quarter, increasing our balance sheet cash position $25 million from last December. And we repurchased $13 million in shares. We continued our new brand awareness campaign to help better position our products and services offerings and drive future revenue growth. We also advanced process improvements and delivered on our cost reduction commitment in the quarter. In a few minutes, I will discuss more details around our recent progress and next steps. But first, Terry will cover our financial performance.

[Terry D. Peterson:]

Thank you, Lee. Earlier today, we reported diluted earnings per share for the first quarter of $0.89, which included losses of $0.02 per share from restructuring charges. Excluding these costs, adjusted EPS of $0.91 exceeded the upper end of our outlook and was 3.4% higher than the $0.88 reported in the first quarter of 2012. The restructuring charges are primarily for employee severance and infrastructure consolidations. Revenue for the quarter came in at $388 million and grew 2.5% over last year despite 2 less business days compared to the first quarter of 2012. All 3 of our business segments performed well. Small Business Services' revenue of $248 million grew 8.1% versus last year on a reported basis but is double digits when considering 2 less business days. While we continue to operate in a weak economic environment, we delivered growth in marketing solutions and other services, checks and in our online Safeguard distributor, major accounts and dealer channels. Financial Services' revenue of $87 million declined 3.8% versus last year but was close to flat when considering 2 less business days. The impact of lower check orders offset the benefits of price increases and higher marketing solutions and other services revenue. Direct Checks' revenue totaled $52 million, which was down 9.9% on a year-over-year basis. This segment was also negatively impacted by 2 less business days. Gross margin for the quarter was 65.6% of revenue, which was down 0.7 points from 2012. Unfavorable product mix and increased material and delivery rates were only partially offset by benefits from price increases and improvements in manufacturing productivity and delivery initiatives. SG&A expense increased $3.3 million in the quarter and was 45.2% of revenue compared to 45.5% of revenue in the same period last year. Increased SG&A in Small Business Services associated with commissions on increased revenue, higher brand awareness spending and the OrangeSoda acquisition, was partially offset by benefits from our continuing cost reduction initiatives in all 3 segments. Excluding restructuring charges, adjusted operating margin for the quarter was 20.4%, which was down 0.7 points from the 21.1% generated in 2012, but slightly better than our expectations. All 3 segments delivered strong operating margins compared to expectations. Excluding restructuring charges, Small Business Services' operating margin of 15.8% was down 1.6 percentage points over last year due to higher SG&A, driven primarily by higher brand awareness spending. Financial Services' operating margin of 26.8% was up 2.6 points from 2012 due to a price increase, better product and services mix and cost reductions. Direct Checks' operating margin of 31.5% increased 0.2 points from 2012 as we continue to realize plant synergies from integrating Custom Direct. Turning to the balance sheet and cash flow statements. We increased our cash and cash equivalents balance by $25 million despite repurchasing $13 million of our common stock to offset expected dilution from employee plans. Total debt at the end of the quarter was $651 million, basically flat from the end of 2012. Cash provided by operating activities was $51.5 million, about the same as 2012. Compared to last year, lower contribution to fund future medical benefits, as well as lower contract acquisition and income tax payments were basically offset by higher variable compensation earned in 2012 but paid out in the first quarter of 2013. Capital expenditures for the quarter were $8 million, and depreciation and amortization expense was $16 million. We are tightening our consolidated revenue to the upper end on a full year basis to a range of $1.545 billion to $1.575 billion. Our strong performance in the first quarter is expected to be mitigated by an unfavorable impact from recent trends in the Canadian exchange rate. Diluted earnings per share has been tightened to the upper end as well, to an expected range of $3.65 to $3.80. There are several key factors that contribute to our full year outlook, including

[Lee J. Schram:]

Thank you, Terry. I will continue my comments with an update on our overall focus and then highlight progress in each of our 3 segments. I will also include throughout a perspective on what we hope to accomplish during the balance of 2013. Our primary focus in 2013 continues to be profitable revenue growth and increasing the mix of marketing solutions and other services revenues. We have created more differentiated, technology-led check offers through investments in automated flat packaging, digital printing and online portals and dashboards. We also have significant growth opportunities in marketing solutions and other services. We will continue to assess potential small- to medium-sized acquisitions that complement our large customer bases, with a focus on marketing solutions and other services. We have strengthened our channels in small business to include financial institutions, online, retail, wholesale, distributors, dealers and major accounts. Deluxe is now more capable of helping small businesses pursue their passion as a trusted provider of a growing suite of products and services of small business needs to market and operate their business, and helping small to mid-sized financial institutions with customer acquisition, risk management and other value-add services offers. Here is an update on our 4 subcategories framework for marketing solutions and other services. We ended the first quarter right in line with our expectations in revenue, with mix in the 4 subcategories, basically in line with our expectations. First, small business marketing is expected to represent approximately 42% of revenue in 2013, with expected growth in the upper-teens this year. We saw strong double-digit growth in the first quarter in the web-to-print space as we cross-sold to our customer base and added new customers through distributors, dealers and major accounts. The second category, web services, which includes logo and web design, web hosting, SEM, SEO, email marketing, social and payroll services, is expected to represent approximately 32% of revenue in 2013, with expected organic growth rates in the mid-teens. We saw a little slower rollout in both wholesale web telco and SEM, SEO major accounts in the first quarter than expected from the $15 million of deals closed in 2012, which we expect will roll out throughout 2013. We saw growth from the prior year in cross-selling bundled presence packages to our retail base and added more new customers, resellers and partners. We continue to reduce web design and SEM campaign cycle times, and churn rates remain low. We added payroll services customers, and many customers added new features such as time and attendance applications. This category also is our focus area for tuck-in acquisitions. We closed the first quarter with approximately 565,000 web hosting customers, and we expect to close 2013 with nearly 750,000 web hosting customers, or up 36% from 2012, as we expect migrations to ramp through the balance of the year. The third category, fraud, security and risk management services, are expected to represent approximately 22% of revenue in 2013, with expected growth rates in the high-single digits. We had a stronger-than-expected first quarter as we added program services for new community banks and fraud and security offers for small businesses and direct to our consumers. We added Banker's Dashboard customers as well. Finally, other financial institution services are expected to represent approximately 4% of revenue in 2013, with expected growth rates in the high-single digits. Key growth initiatives here include adding new Cornerstone and SwitchAgent clients. We continue to expect marketing solutions and other services revenues to be approximately $330 million to $340 million in 2013, up from $285 million in 2012, with organic growth in the mid-teens. If achieved, this performance would translate to a total revenue mix of around 22% of revenue, including a year-end exit run rate above 25% of revenue towards our 25% mix goal and up from 19% in 2012 and 16% and 13% the previous 2 years. Our new brand awareness campaign was in market throughout the first quarter. We continue to run the 3 television commercials we started in late 2012 during the first 5 weeks of 2013, then paused for about 6 weeks as planned, and then ran them again for 4 weeks through mid-April. We also continued print and digital online ads during these same timeframes. This media will continue at various times through the balance of 2013 and focused first. For competitive reasons, we will not disclose investment levels other than to indicate that it is a multimillion-dollar campaign, and all planned spending is included in our current outlook ranges. We have established return-on-investment criteria based on the number of impressions, expected site visits and online leads. We will use results against these metrics to guide us as we progress on this new brand journey. It is important to remember that this campaign is primarily focused on improving brand awareness and not a targeted direct response campaign. Here are some metrics we are seeing so far in the campaigns. Online click-through rates are over 50% above representative benchmarks. Traffic to deluxe.com is up over 20%. YouTube views of the 3 commercials are now approximately 900,000, and we are closing new business both online and in our dedicated call centers. The calls we are receiving are some of our most relevant and best converting lead sources. Now shifting to our segments. In Small Business Services in the quarter, as expected, we did not see any notable improvements as the economic climate for small businesses remain sluggish. We had strong performance as revenue grew 8%, even with 2 less business days in the quarter. Checks and forms performed above our expectations. Our results from targeted customer segmentation in the call center improved. New customers from our financial institution, Deluxe Business Advantage referral program, and through our direct response campaigns, remain strong. Response rates, average order value and conversion rates improved. Our online Safeguard distributor and dealer channels grew revenue over the prior year. We also saw strong growth in web, SEM and payroll services. Again, we ended the quarter with approximately 565,000 web hosting customers. We continue to closely monitor the small business market. Optimism indices increased slightly in January, ramped in February, but plunged in March and remained in recessionary territory with no indication of a surge in business confidence. Current levels are among the lowest levels in nearly 40 years. 77% of business owners expect business conditions over the next 6 months to be the same as they are now or worse. More owners are planning to reduce employment than hire in the coming months, and more plan to reduce inventories than plan to order new stocks. They continue to spend cautiously, more in maintenance mode, scrutinize purchases and experience tight cash flow. In summary, current optimism indices have been trending downward over the past year and remain in recessionary levels. The good news is that other than taxes and regulation, increasing sales continues to be a small business owner's #1 pain point, and our portfolio is significantly more robust now, with many offers to help them here. As the economy recovers with the transformative changes we are making to deliver more services offerings that help small businesses get and keep customers, Deluxe is better positioned as that indispensable partner for growth. Our focus for 2013 is on

[Operator:]

[Operator Instructions] And your first question comes from the line of Charles Strauzer of CJS Securities.

[Charles Strauzer:]

Two quick questions on -- thanks for all the transparency, by the way, on the various pieces there. But if you look at the organic growth of the quarter -- I know you gave out some of the segment information on a kind of apples-to-apples, normalizing up the different days. But what was the overall organic growth if you do the same?

[Lee J. Schram:]

I don't know that we -- I don't know that I know that, Terry. Do you have that number?

[Terry D. Peterson:]

The organic growth? The only piece that's not organic this quarter is a little bit from the OrangeSoda acquisition from last year. It's not significant at all. Most of the growth is all organic. In the Small Business Services segment, we had growth of 8.1%. It's still north of 5% for that segment, if you were to just look at the organic piece.

[Jeff Johnson:]

And, Charlie, another marker out there for you, I think the number that we calculated with 2 -- with the -- if the 2 days were comparable was a 5.6% growth for the quarter. So we would have been slightly under that on an organic basis, but not a lot. It would have been very strong on an apples-to-apples compare.

[Charles Strauzer:]

So still very good in the -- nevertheless?

[Jeff Johnson:]

Very good. We're very pleased.

[Charles Strauzer:]

And then on the new contract that you won, I know you can't give out too many details obviously yet. But could you maybe rank it in terms of the type of client it is versus maybe some of your other clients in terms of -- was it medium, large? Or is it kind of the upper end of your contract range? Or can you give a little bit more color there?

[Lee J. Schram:]

Again, we're really excited about it. Hopefully, at some point here, we'll be able to release the logo. It's a well-known logo. And I would say it's a -- again, it's a nice-sized national opportunity for us. So we're not going to obviously get a whole year's worth of revenue from it. It will -- right now, the timing, as I said in my comments, Charlie, is in the third quarter. But we are really excited about it. I think when we get the logo out there, I think it'll put some excitement on our company, and I think it'll put some excitement out on the street.

[Terry D. Peterson:]

Yes. The other thing, too, Charlie, is when we do start producing checks for them, that will benefit both our Financial Services segment, as well as the Small Business Services because they will be going after the DBA, Deluxe Business Advantage program as well. So it'll actually benefit both segments.

[Lee J. Schram:]

Yes, that's a great additional comment. Charlie, one of the things we like about this financial institution is they have a very strong focus on small businesses. And again, as you know, that's a key focus area for us as well. So we just think it's a great match with us and this new institution.

[Operator:]

We have no further questions at this time, so I'd now like to turn the call back over to Lee Schram, CEO.

[Lee J. Schram:]

Wow. Only one question. Okay. So let me just close with thanking everybody for participating. And as I normally say, we're going to roll up our sleeves, get back to work, and we look forward to providing another positive progress report on our next call. And I'll turn it over to Jeff for some closing housekeeping.

[Jeff Johnson:]

Thank you, Lee. This is a reminder that a replay of this call will be available until May 9 by dialing [phone]. When instructed, provide the access code 33314252. The accompanying slides are archived in our Investor Relations website at www.deluxe.com/investor. Again, thank you for joining us. Have a great afternoon.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and good day.